Focus On A Framework For Flexibility
The Age
Friday February 24, 2006
Corporate governance makes a difference as much for what it leaves alone as for what it does, writes Ronald Gilson.
DOES corporate governance matter? Easy question, given how much attention is being paid to the subject all over the world. But the easy answer immediately gives way to a second question: why does corporate governance matter? Now, that question is not so easy, but the answer is very important. Scholars as well as the World Bank, the International Monetary Fund, and the Organisation for Economic Co-operation and Development have come to focus on the differences among national corporate governance systems and to proclaim best practices. The razing of trade barriers that gave rise to globalisation makes it obvious that institutional differences among national governance systems have competitive consequences. Competition is not just between products but also between the governance systems that support production. In the 1970s, before the bursting of the Japanese bubble, the main bank system was the wave of the future: this array of complementary institutions - the bank to intervene in the event of very poor performance and extensive cross-shareholdings in place to protect companies from pressure from outsiders - was believed to be necessary to lean manufacturing, the emerging standard of efficient production. In contrast, the US system, built upon companies unprotected from the pressure of sharemarket performance assessment, was believed to encourage short-term thinking. Respected commentators such as Peter Drucker and Michael Porter urged a shift from sharemarkets to banks as a way of getting the US economy back on track. Not long thereafter, Japan entered a seemingly endless period of recession and the US economy boomed. The US system then became the apparent end point of corporate governance evolution, as could be plainly deduced from the IMF and World Bank's imposition of US-style corporate governance reform as a condition of financial aid in the wake of the East-Asian financial crisis.So, what happened to the US governance system that moved it from 1970s laggard to 1990s market leader? The short answer is, very little; at least if one measures change by reference to the formal elements of the corporate governance system. The Delaware corporate statute looked pretty much the same in 1970 and 1995. Rather, the critical changes took place not in the formal aspects but in the product, capital and managerial markets in which US companies operated. The genius of the US corporate governance system is that it did little in response to these changes; that is, it did not allow managers to wall the company off from changes in the economic environment. And there were dramatic changes in the markets in which US companies participated. Entering the 1980s, many US companies had become conglomerates after a takeover binge in the 1970s, which provided companies with shelter from poor performance by individual units and kept free cash flow underemployed in badly run businesses. At the same time, the relentless tariff reductions had opened US companies to competition from Europe and Japan, which had completed the recovery from World War II. Finally, the capital market underwent substantial changes. The shares of large public companies had become concentrated in intermediaries whose sole object was to maximise shareholder value. At the same time, the democratisation of the debt market through the development of high-yield debt - junk bonds - made even very large companies vulnerable to hostile takeovers by new kinds of bidders whose strategy was to break up inefficient producers and sell the pieces to experienced operators.The US experience in the 1980s highlights the central characteristic of US corporate governance: it leaves companies exposed to market forces. Despite the objections of threatened management and the dislocation that is inevitably associated with change, US companies have to confront shifting economic conditions or the market will do it for them. As a result, the US economy has the capacity to change quickly. The 1980s market-forced restructuring in the US remains to be completed in Japan and Europe.The US experience teaches that what the corporate governance system does not do is more important than what it does. Economic change is inevitable and, in a global, technology-driven environment, the rate of change is only going to increase. A corporate governance system that facilitates adaptation to change by not allowing incumbents to build a temporary moat around the castle, however comforting it may seem, captures almost all of what is important in corporate governance.Ronald Gilson is Meyers professor of law and business, Stanford University, Stern professor of law and business, Columbia University, and fellow, European Corporate Governance Institute. This is an edited version of the keynote speech to be presented today at a joint ISS Australia/University of Melbourne conference in Melbourne.
© 2006 The Age